Echo’s fate to be sealed by few

John Story might well be irritating the life out of James Packer but that would, for the moment, seem to be his job given the billionaire’s increasingly aggressive bear hug of Sydney’s east coast casino operator.

Packer delivered on his promise of Tuesday’s media leak and has forced Echo Entertainment shareholders into emergency session to consider whether Story should be removed as chairman and replaced by Victoria’s own Jeffrey Gibb Kennett.

Kennett is a man to be admired for his time as Victorian Premier and even more for his success as the President of the Hawthorn Football Club.

But, quite frankly, it is hard to see why any one other than Packer and just maybe his fellow Crown shareholders would choose to replace Story with the stalking billionaire’s nominee.

As things stand Packer owns 10 per cent of the orphan child from the break up of Tabcorp and is Echo’s competitor.

Certainly, Packer would seem to be the natural owner of Echo given it fits so neatly with his broader strategy to capture a young lion’s share of the growing Asian gambling market and a merger could generate an estimated $100 million or so in synergies that no other potential bidder could extract.

But Packer can’t own any more of Echo without removing ownership caps that are sustained by both the NSW and Queensland governments.

And, even allowing for the potential indulgence of both state governments on cap removal, he can’t bid for Echo any time soon because Crown’s balance sheet can’t currently sustain the $4 billion price tag.

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So Crown could only bid by using scrip or by raising more capital. Neither option appeals to Packer because he would be diluted from his controlling 50 per cent position given that he will not have the readies until (and if) he sells his $1 billion, 50 per cent stake in Consolidated Media.

Nonetheless, Packer means to express very public control over Echo by bringing an end to the Story era. The ambition, it is claimed, is to secure NSW government support for the addition of a second property to the Echo licence and make that property a harbour-side beast at Barangaroo.

Packer insists that Australian tourism needs a need six star hotel experience in Sydney, one that would include a haven for the super wealthy high rolling gamblers that currently make Melbourne’s Crown their Australian destination.

The fact is, of course, that Sydney is a far more natural destination for the uber-wealthy who are squired around the Asian casino circuit than is the great southern capital. Currently that looms a bit of a problem for Packer and Crown because, for pretty much the first time since Melbourne’s casino opened its doors in 1997, it faces realistic competition in the rich high roller market.

Echo has spent better than $900 million over three years on revitalising an offering that was patently never competitive under its previous ownership structure. Tabcorp is a good wagering business but it was nothing like a productive steward of its two casinos.

The point to appreciate here is that Packer’s play is as defensively motivated as it is laden with commercial aggressive intent.

But if all goes to plan, Packer could turn The Star’s revival to his own advantage by leveraging influence over the board to extract value from Echo in the form of some sort of deal on the licence and delivering Barangaroo’s top shelf gambling option to his global casino network.

But the question is, why would a minority shareholder of Echo want any of that to happen?

I mean, it currently owns all of a licence to operate the only casino in NSW until 2019. Which gives it a window of another seven years to ratchet up its market share ahead of any debate over who should own that licence and whether or not it should remain exclusive.

That exclusivity is part of the Echo value proposition and it beggars belief that any independent board would want to surrender a part of that to a shareholder who is a competitor with extracting a premium that reflects the potential value diminuation.

Now, much is made of the obvious fact that Packer is following the Kerry Stokes template here in that he appears set on asserting a shaping influence over a board from a minority ownership position.

But if I am an Echo shareholder, I would want to hope that what Stokes did at Western Australian Newspapers, Packer cannot do for Echo.

Before Stokes translated a 19 per cent WAN shareholding into boardroom influence then into effective control, the media house was trading a $7 a share.

As it turned out Stokes managed to transfer significant value away from WAN by merging it with Seven Media Holdings, in which he owned a stake of similar influence. That deal was done at an inflated 9 times EBITDA. Not only does recent history suggest those earnings were at a cyclical high given the recovery of competitiveness of traditional television market leader Nine, but Seven arrived with $3 billion of debt. Today WAN trades at $2.50 per share.

So what are Story’s sins according to Packer?

Well, he complains that Echo’s earnings growth since 2005 has not matched that of his 50 per cent owned Crown and that the chairman has failed to manage regulatory risk and government relationships. And he suggests that Story has failed to act on breaches of Echo’s code of conduct in the form of leaks to newspapers that attempted to mitigate damage being wrought by the ugly fallout of the dismissal of Echo’s former head of The Star casino, Sid Vaikunta.

Story would argue that Echo has addressed the cause of its under-performance through a substantial capital campaign and its release of a new management team steeped in the casino business from the constraints of being owned by a wagering business.

And he will certainly point to results of inquiry by the NSW Gaming and Liquor Commission into the Vaikunta affair in rejecting claims Echo breached internal guidelines in managing its public affairs problems.

The truth is, of course, that sustaining or defending Packer’s public case against Story will have nothing to do with who wins this contest. But it is theatre necessary to Packer’s strategy.

According to analysis by CLSA’s Sacha Krien, history says that the weight of Echo’s institutional ownership will limit Packer’s chances of successfully unseating Story.

Krien suggests that back in March retail investors spoke for but 30 per cent of Echo and that the tension since would likely have attracted hedge fund interest, further reducing that proportion.

Just on the issue of who owns Echo, there has been some comment that there are a several institutional owners that are long in both casino operators. As it turns out, it seems there is but one, namely Perpetual, which boasts 9.2 per cent of Echo and 10 per cent Crown. Ausbil Dexia owns 5.5 per cent of Echo but is not a big holder of Crown.

“To be successful in a proxy battle, we believe Crown needs allies amongst the institutional investor community," Krien wrote in a note to clients yesterday. “Applying the same voting patterns we saw in WAN/Seven, we believe Crown would need support from institutional investors holding (greater than) 17 per cent of Echo stock to achieve (the) 50 per cent of votes cast at a general meeting. At present, we believe this is unlikely given investors are more likely to force Crown to bid for Echo than hand over control at no premium."

Given there is no one in Australian business with a brain for numbers like James Packer, why would he bring on a proxy battle that the odds say he is condemned to lose?

Well, first, it gives him breathing space while he runs the gauntlet of approvals necessary to establish the sort of ownership platform that would generate more material influence.

And then, given the assault on Echo’s numbers and its leadership can be sustained, Packer might depress the target’s share price while he taps, and then maybe influences, the mood of Echo’s senior shareholders.